Reflections on the Cyprus disaster

Functioning banks certainly are a key part of a modern financial system but why should the same be said of the toxic zombies who are blundering round the current financial landscape?

And how did these rotten banks get so big in the first place? It’s because governments and central banks prop them up. Bad banks rarely go out of business, they just lumber on, soaking up and destroying more wealth. Goldman Sachs and JP Morgan were bailed out five times in the 20 years before 2008.

The second lesson is that there really is no such thing as private property. In extremis the government considers itself entitled to any amount of your property it desires even if, as in the Cypriot case, it means revoking its own commitments to protect bank deposits.

But then this is the logical outcome of taxation. If you think that a shortage of government revenue can be solved by the government simply helping itself to someone else’s revenue you really can’t have a philosophical problem with this. If you believe in the 50p tax rate this is where you end up.

The last paragraph is particularly telling. It is good, in a grim sort of way, that people have been alarmed at the idea of governments grabbing savings. But what on earth do people think governments do already? Consider the central banks’ “quantitative easing” policies. Printing money benefits those who get the new money first against those who do not; savers lose out when a government “reflates” an economy. In the UK, for example, inflation – understated by government statistics – is in the low but significant single digits and over a relatively short period, will devastate savings due to the impact of compounding. The proposals from leftist politicians for a so-called “wealth tax” in the UK is merely another form of property rights confiscation, but then again, income taxes are a form of confiscation in that they confiscate the products of work. Confiscation is what governments with a monopoly on the use of physical force do. It is one of their defining characteristics.

Meanwhile, Detlev Schlichter has an interesting new item up about the Cypriot disaster. What is notable about it is that he does not adopt a lazily predictable “bash the eurozone” stance here.

In particular, Schlichter kicks against the assumption that what was proposed – taking a slice of deposits – is somehow uniquely evil:

I am a free market guy. I am in favor of laissez faire so I always like to see placards that read “Hands off”. One could see such placards at demonstrations in Cyprus yesterday: “Hands off Cyprus”. That is great. But be careful what you wish for. A proper hands-off policy means letting the chips fall where they may. That would certainly mean no bailout and thus total collapse of the Cypriot banking system and the Cypriot economy. Don’t forget that Cyprus and its banks and its depositors are still being bailed out with other people’s money here.

That is also what some of my libertarian friends don’t seem to get when they speak, as some of them did yesterday, of another incident of the ‘the state stealing from its citizens’ or of confiscating their property. As much sympathy as I usually have with these views, in this instance they are simply mistaken. If this were expropriation it would mean that the act of abstaining from this expropriation – of the expropriator simply doing nothing – would mean that the ‘victim’ keeps his property. But if the EU did nothing in this situation – “hands off”, laissez faire – it would mean that most depositors, including those under €100,000, got wiped out completely. The choice is not between keeping everything and paying a ‘levy’, but between paying a ‘levy’ and losing almost everything.

March 20th, 2013 |

20 comments to Reflections on the Cyprus disaster

The left, whether sincerely (such as the more innocent “Occupy” people) or insincerly (such as Putin’s boy Max Keiser), claim that ever more government Welfare State spending could have gone on for ever if only it had not been for credit-bubble banks. But this is almost the opposite of the truth.

In reality the taxes from the profits of the credit bubble banks (and financial industry generally) financed the the expansion of government – not in all cases, but in many. The one case where one can argue that the left has a case is Ireland – where, had the government just allowed the banks to go bankrupt, the economy might have carried on without a vast government debt and deficit (the German government put pressure on the Irish government, in order to make sure German creditors were paid, – and these “nationalists” collapsed like a House of Cards).

Britain was a classic example of this – Mr Brown did not love bankers, but he loved the money he got from bankers (because it allowed him to finance his expansion of government). That is why the Bank of England and the Federal Reserve ACTIVELY PUSHED the credit bubble by expanding the money supply (PREVENTING any real correction).

It was the same in many other countries – yet in the United States, Britain and so on “boom” inevitably turns to “bust”.

They did not let the credit bubble financial system – because there was no “Plan B” (no other way of financing the expansion of government)

The United States has had a real expansion of oil and gas production (on privately owned land – the Federal government, and some State governments [such as Califorina and New York – no surprise there] have tried to HOLD UP the expansion) – this is real economic activity, it is not enough (not nearly enough) to prop the economy as a whole, but it is real (by the way I am NOT trying to back out of my prediction that the United States economy will start to decline THIS year – I know a lot of people are saying January 2014 [when the rest of Obamacare kicks in] but I still believe it will start THIS year).

But what does Britain have? Or Greece? Or Cyprus? Or Italy? Or Spain? or……. Even where there is energy other factors make a lot of new business activity unlikely – for example France has a lot of nuclear power stations (GOOD!) but would you set up a new manufacturing enterprise in France? With their taxes and labour market regulations?

There is nothing to even partly prop up the economy.

These economies are zombies – the “Walking Dead”.

And no absurd lies (such as the you-know-what magazine talking about a “cut” in government spending which HAS NOT HAPPENED) are going to resore these economies to life.

There needs to be a vast real reduction in TOTAL government spending (a very dramatic one) – not hitting one form of goverment spending to expand another form of government spending (such as finacial sector bailouts, or Corporate Welfare “infrastructure” schemes).

But is that true? Most times this calculus is based on the assumption that the one creditor that must be protected, the last one to lose its money, must be the European Central Bank. Anything else is unthinkable – it would expose the continuing lie that the ECB’s loans are the merely loans at zero risk, and prove the transferunion is already in effect.

I am afraid Detlev also seems to falling into this error.

So what if all equity, wholesale depositors and other professional bondholders – including the ECB – were wiped out, would there still be debt left that would require retail depositors to take a haircut? Surely not; who would such debts be owed to?

In other words, the Cypriot man in the street is having his savings confiscated to protect the seniority of the ECB’s loans.

I think Detlev is overstating his case here. Yes – in the end – all bank depositis (other than those stuck in a safety deposit box) are effectively loans from the depositor to the bank, but the hitherto government backed guaranteer of deposits below a certain trheshhold ( €100,000 ) has been key to getting the average working slob to trust the bank in the first place. By removing that guarantee we’re looking at people no longer trusting the banking system. Well done ECB et al! well done!

Personally I have been keeping a comparitvaly small amount of such assets as I have in cash in bank form for a while now. Not because I expected soemthign liek this, but based on the fact that we’re seeing competitive devaluations of all the major fiat money currencies and that has to be going to end in tears at some point. In that regard, while it stll smarts a bit, I think that paying to build the house I did in Japan a year ago was a good thing even though at the time the yen was rather over-valued comapred to sterling and the US$.

The positive side of this (from a libertarian perspective) is that we are seeing that no government can be trusted to keep its promises and that there is much to be said for untraceable small bills for payments (and indeed the mattress – or futon – for savings). The black economy has just received a massive boost all over southern europe and possibly everywhere else where people can read what is going on.

Detlev Schlichter is right-er in his description of the true state of affairs than others, as described. But I don’t think he makes the complete point (unless I am too dumb to see it). He makes the contrast between

a) The Cypriots rejecting the ‘levy’ and losing everything vs

b) The Cypriots accepting the ‘levy’ and losing almost everything.

With the real state of the Euro and the coming issues with a half-a-dozen PIIGS, I think the second choice is better expressed as

b) The Cypriots accepting the ‘levy’ and still losing everything, just in a few months instead of a few weeks.

As Paul Marks notes, this is already descending into a game of nationalism and tribal interests. If it was just the Cypriots, who had screwed up their economy and banking system, the rest of Europe would be content to let them fold. But because some rich and influential Russians stand to lose a metric shed-load of money if the Cypriot banks collapse, all of the sudden, the Cypriot banks must be saved at any cost! To paraphrase Mary Contrary, the Cypriot man-in-the-street is going to be made to take a haircut in order to keep cheap Russian gas and oil flowing to Germany and the other major Northern European nations.

“So what if all equity, wholesale depositors and other professional bondholders – including the ECB – were wiped out

Even if that happened in reality, the ECB is essentially a political entity and would merely describe the loans as defaulted and passed over to the Paris Club for renegotiation.

The obvious reality is that even in the most optimistic circumstances the ECB will probably only get a nominal return on these loans. From a discounted cash flow perspective (i.e. Real Terms), the renegotiated rates are so low compared to prevailing inflation (ignoring bogus interest rates) that the loans are already in the red in real terms.

This is just the boy with his finger in the dyke. Leaks are springing everywhere else and water is flowing over the top. The EU / ECB would like to see this ‘crisis’ affecting their politically real, but economically foolish single currency to go away, but it is being tested by good old-fashioned, hard-to-ignore reality.

The debt has become all consuming for most of Club Med and if this crisis is to be brought to an end there must be a moment of Catharsis.

My preference is for Germany to leave the Euro, but this would make them pariah’s across Europe – which they are already, so they should just leave and restore the Deutsch Mark.

In particular, Schlichter kicks against the assumption that what was proposed – taking a slice of deposits – is somehow uniquely evil

There are two sides to this issue.

On one hand, you can argue that this isn’t confiscation at all. If you are receiving interest, you are involved in a risk taking investment and morally, it is right that you should be the one to shoulder the burden of that risk. On that basis, forcing this sort of debt-for-equity swap is perfectly reasonable and arguably the best way to handle a bank failure.

On the other hand, other taxes are at least generally levied in an upfront manner. EU rules which mandate that all savings up to 100,000 Euros are protected are intended to reasure savers that their money is completely safe. In facilitating the levying of this tax, the EU is breaching a previous bargain.

Yes, I think your second point dominates. Risk that someone will deliberately rob you or renege on previous commitments is different from the risk of events not directly under the control of someone who’s party to the contract. And a government that guarantees deposits is a de facto party to every deposit contract.

At least, that’s the contractual reality, as I see it. But I suppose it’s fair to say that the reality reality is that governments are unreliable contractual partners, when it comes to this sort of thing. You’re entering into a contract with someone with an atrocious credit history.

Re: Detlev Schlichter. We do not arrive suddenly at the point where we lose everything, in the same way we do not suddenly go over a cliff edge, there is a journey to it, warning signs ignored, a large impenetrable crash barrier supposed.

We arrive in such predicaments out of a false sense of security that it won’t happen, because we are led to believe it cannot happen.

It is only if we accept the possibility that disaster can and will strike, and we gain that understanding by experience or observation, that we avoid it.

So yes, Cyrpus should crash and burn because then the rest of the people, not least the idiots in charge will not swan along under the impression that the worst cannot happen.

The worst always happens later if not sooner unless we do not start on the journey to its inevitable destination, over the cliff.

The general population has to understand that voting themselves ever increasing access to the National treasuries has the consequence that the money will run out, in fact has run out and it will then be a quick fall to the foot of the cliff with a painful if not fatal landing.

Had the EMU solved *any* of its crises (as opposed to lying through its teeth about how they were being settled), then I would agree with Schlichter, who has forgotten more economics than I’ll ever know.

But the EMU hasn’t done any of those things, so like the bizarre offers that were put on the table for Greece, I don’t see these as legitimate. The answer, and it will come sooner or later (but dear lord sooner so we can lance the boil) is default and reversion to some other currency.

I’m with llamas on this (although Alisa may be correct about the Russian angle). It seems to me that, with the handwriting clearly on the wall, Cypriots would be best served by accepting the ‘levy’ and using the few months of grace purchased thereby to withdraw all their cash from domestic banks and use it to purchase hard assets (maybe gold), or simply stashing it under the mattress. In the long run this may prove to be fairly inexpensive ‘tuition’ for them (and an object lesson to the residents of other Club Med states).

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